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Basic Question 16 of 18
Using greater amounts of debt in the capital structure increases the cost of equity because ______
B. equity holders only receive income after the debt holders' claims have been met.
C. Greater amounts of debt in the capital structure do not increase the cost of equity.
A. debt holders have first claim on the firm's net income.
B. equity holders only receive income after the debt holders' claims have been met.
C. Greater amounts of debt in the capital structure do not increase the cost of equity.
User Contributed Comments 11
| User | Comment |
|---|---|
| katya37 | doesn't A say the same thing? |
| nike | not exactly, katya37. There are other groups that come before debt-holders. The certain thing is that equity holders come after debt holders, but you cannot say debt holders are the first. |
| Rotigga | Payment of Taxes takes precedence over debt holders, so A is not the answer. |
| ssradja | good point rotigga |
| tabulator | Net income is after-tax, Rotigga |
| gulfa99 | debt holders dont have claim to the firms net income. Debt holders are paid interest for lending money, where as net income after interest cost and taxes goes to reserve or is paid as dividend. Equity holders have right over the net incom. |
| bidisha | yup gulfa |
| jonan203 | katya, it depends on where the type of debt (senior, subordinated, mezzanine, etc) you own lies on debt pecking order. just because you hold debt, doesn't mean your first in line, irrespective of taxes. |
| tybe0012 | COST OF equity |
| ascruggs92 | Equity holders are last in the pecking order, that's why their claim to the firm's revenues is the bottom line of the income statement. The equity holders' claim to firm's revenues (net income) is net of interest expense. Therefore debt holders do not have first claim to Net Income because their claim on the firm's revenue is factored into net income and therefore has already been met. If it said "debt holders have first claim to EBIT," then A would be correct. |
| walterli | why not C lmao |
I am using your study notes and I know of at least 5 other friends of mine who used it and passed the exam last Dec. Keep up your great work!
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Learning Outcome Statements
explain the Modigliani-Miller propositions regarding capital structure
CFA® 2024 Level I Curriculum, Volume 2, Module 6.